Lifestyle funds are “premixed” portfolios, generally designed so that participants can make a single investment choice and invest in a diversified portfolio of funds. Frequently, the funds are oriented toward a participant’s age, or number of years until retirement.
The Hewitt study found that participants were investing in both lifestyle funds and in individual fund choices, effectively “doubling up” in certain categories. In fact, only 12% of the participants with some allocation to lifestyle funds had placed 100% of their non-company stock monies in a single lifestyle fund.
For example, a participant might choose to invest 50% of their balance in a lifestyle fund comprised of 60% stocks and 40% bonds, and invest the remaining half of their account balance in a fixed income fund. The combined effect of those decisions would put 70% of the participant’s balance in fixed income investments.
“We found that very few participants were simply matching their risk profile with an appropriate lifestyle fund,’ said Lori Lucas, defined contribution consultant, Hewitt Associates. “In fact, many participants who used lifestyle funds weren’t choosing one lifestyle fund, but allocating to several lifestyle funds at once. Clearly, lifestyle funds are not being used as the simple, straightforward investment solution they are intended to be.”
Hewitt’s research found that participants do pay attention to time horizons in choosing lifestyle funds. Younger participants had a bias toward aggressive lifestyle funds, while older participants have a bias toward conservative and moderate lifestyle funds.
However, lifestyle funds do appear to encourage investors who otherwise wouldn’t invest in equities, such as older participants, to do so.
Plan sponsors might:
- Require participants to invest 100% of their balance in a single lifestyle fund
- Consider offsetting the mix/match mentality by making the conservative and aggressive lifestyle funds better differentiated in terms of equity allocation
- Communicate the lifestyle choices as a separate category of investment for participants that aren’t comfortable, or ready to make individual fund choices
- Consider offering third-party investment advice
According to Hewitt, nearly a third (30%) of plans offered a lifestyle option in 1999, up from 19% in 1997 and 9% in 1995.
The Hewitt study examined the use of lifestyle portfolios in a U.S. company’s 401(k) plan with 4,000 participants and 12 investment options, including three lifestyle funds.
The results were supported by a subsequent examination of the use of lifestyle funds at four additional companies with more than 90,000 participants.